TaxProf Blog

Editor: Paul L. Caron, Dean
Pepperdine University School of Law

Wednesday, September 26, 2012

Why Mitt Romney Should Pay a Lower Tax Rate Than the Rest of Us

Slate:  Why Mitt Romney's Effective Tax Rate Is So Low And Why It Probably Should Be, by Matthew Yglesias:

The main reason Romney's effective rate is so low is that the American tax code contains a lot of preferences for investment income over labor income. That's something that strikes many people as unfair on its face, and particularly unfair since it often means very low rates for extremely rich people like Rommey. ... But this is definitely an issue where the conservative position is in line with what most experts think is the right course, and Democrats are outside the mainstream.

The reasoning is basically this. You imagine two prosperous but not outrageously so working people living somewhere—two doctors, say, living in nearby small towns. They're both pulling in incomes in the low six figures. One doctor chooses to spend basically 100 percent of his income on expensive non-durables. He goes on annual vacations to expensive cities and eats in a lot of fancy restaurants. The other doctor is much more frugal, not traveling much and eating modestly. Instead, he spends a lot of his money on hiring people to build buildings around town. Those buildings become houses, offices, retail stores, factories, etc. In other words, they're capital. And capital earns a return, so over time the second doctor comes to have a much higher income than the first doctor.

So then there are too different scenarios:

— In the world where investment income isn't taxed, the second doctor says to the first doctor "all those fancy vacations may be fun, but I'm being much more prudent. By saving for the future, I'll be comfortable when it comes time to retire and will have plenty left over to give to my kids."
— In the world where investment income is taxed like labor income, the first doctor says to the second "man you're a sucker—not only are you deferring enjoyment of the fruits of your labor (boring) but when the money you've saved comes back to you, it gets taxed all over again. Live in the now."

And the thinking is that world number one where people with valuable skills take a large share of their labor income and transform it into capital goods is ultimately a richer world than the world in which such people just go out to a lot of fancy dinners.

That's the theory, at any rate. It's a pretty solid theory, it's in most of the textbooks I've seen, and it shapes public policy in basically every country I'm familiar with.

Ezra Klein's WonkBlog (Washington Post):  Why Romney’s Tax Rate Should be Low, by Dylan Matthews:

[T]he disagreement among economists isn’t about whether people like Romney are paying too little. It’s about whether or not they’re paying too much.

Chart 1

For contrary views, see:

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This Slate article is nonsense. In order for an argument about lower tax on investment income to have any bearing you have to have an investment. Romney's tax accounting says he got his interest in Bain Capital as compensation when it was worth nothing. So there was no upfront tax on capital. No matter how high your rate of return, a 1000% rate of return on zero capital is still zero. When he got money distributed on his partnership taht was the first and only tax he had to pay. The double tax on capital argumetn requires that the first tax be ordinary income.

Posted by: Calvin H. Johnson | Sep 26, 2012 2:37:33 PM

Matt must have skimmed all those textbooks he was reading. Economists see no particular moral value of saving versus spending or vice versa. To them, its just a matter of keeping an economy in balance.

Right now, aggregate demand is something like 14 percent below trend. Savers in the other hand are vying with each other to buy 10 year bonds at 1.5 percent interest.

The grasshopper doctor in Matt's article who wants to live it up is better for the economy right now than the ant doctor. The upper income cohorts are always in the aggregate savers. Right now the better policy is to tax away some of the upper income taxpayers' income that would otherwise be saved and to spend it, preferably on useful stuff that has high multipliers, even if it makes Republicans apopletic. That's not always the right answer, but its the right answer now.

Posted by: Jim Harper | Sep 26, 2012 8:35:29 PM

This is unpersuasive. All sides of the taxation debate are very resourceful at thinking of self-serving ways why their particular brand and level of income is deserving/worthy/positive, and should therefore be taxed at a lower rate than everyone else. The only surprise is seeing a Matt Yglesias article in Slate proposing this particular argument. I'd have expected him to push "spending with high multipliers" or some such nonsense.

Posted by: No-no-no | Sep 28, 2012 4:40:48 PM

Flaw #1: whether or not investment income is taxed, Person #2 is only taxed on the amount that exceeds the basis in the investment. $100 earned by #1 and #2 is NOT taxed in either scenario. The investor also has the opportunity to take a loss on the investment. The spender has to pay sales tax and potentially other taxes (every buy an airline ticket or look at a phone bill?) as opposed to the saver who spends nothing.

This is also premised on the idea that the capital gains tax lobby is backed by labor. It isn'y. It is backed by the wealthy who do not pay FICA, SECA, or Medicare tax because they do not work. Their income comes from capital not labor. Workers pay roughly 10-20% in ta (FICA/SECA -- Social Security Tax -- and Medicare) BEFORE they pay a dime income taxes.

Posted by: taguy | Sep 29, 2012 5:03:57 AM

Actually if you tax only the gain, when funds are pulled. You are not double taxing the income.There are still plenty of reasons to invest even if you pay one rate on all income.

Posted by: Charlie | Oct 3, 2012 2:22:34 PM

I used to think that this would have been a bad thing (giving investment taxes a break over labor taxes) but as I get older I start to understand the need for reinvestment. I work as an I.T. technician fulltime and started small eCommerce sites in the last year in hopes that one of them grows in a solid business where I can hire someone to run it and so far one seems to be working. If this keeps growing I may get a chance to hire my first employee. If someone would have explained this to me a few years ago I would have sided on the side that disagreed with taxing labor and investment incomes at different rates.

Found this article on accident looking for something unrelated to politics but still very interesting and enlightening and it fits what I am trying to do anyways. Not totally sure it slid me in the Romney vote though. I'm still undecided...


Posted by: Ed Newman | Oct 7, 2012 5:53:02 AM